Given our better healthcare and increasing longevity, retirement can last much longer than it ever used to. Making your retirement income go further by effective retirement planning is paramount to ensuring your life after work is comfortable and sustainable.
Investment Solutions is here to help you make the most out of your retirement years.
Pension Commencement Lump Sum (Tax-Free Cash)
When planning to draw your pension benefits, one of the first things to consider is whether you would like to draw out any Pension Commencement Lump Sum (also known as Tax-Free Cash) from your pension fund. Under current legislation, up to 25% of the fund can be drawn out, free of tax. This can be used for anything you wish, such as home improvements, paying off your mortgage or a long holiday abroad.
Retirement income can be divided into three main categories.
1) Scheme Pensions - typically, drawing your income directly from your employers Occupational Pension Scheme.
2) Annuities - taking your income as an regular income for the rest of your life. Commonly associated with drawing income from Personal Pension Plans/ Stakeholder Pension Plans
3) Unsecured Pensions - Flexi-Access Drawdown, Capped Drawdown and Phased retirement
1) Scheme Pensions
The full details of your scheme pension should be outlined in full in your pension member's booklet. It is normal to receive a copy of the scheme rules on joining and you can probably access a copy of it from your company HR department.
Annuities are used to provide a pension income, in the case of pensions this income is guaranteed for life. The pension lump sum is exchanged for a pension income. Once the annuity has been bought, the contract cannot be reversed - the pension capital becomes the permanent property of the annuity provider.
The level of income that you will receive from an annuity depends upon several main factors:
- The level of Investment
- Age of 'annuitant'
- Health and lifestyle
- The prevailing annuity rates at the point of annuity purchase
In general, the older an annuitant the higher the income which can be secured.
Annuities are normally supplied by life assurance companies. The underlying 'annuity fund' is usually invested in fixed interest investments, such as long term government gilts in order to maintain the guaranteed income and ensure regular income payments are made to annuitants.
Annuities can be set up to provide different benefits and options:
- Spouse’s pension (to protect a spouse, by providing an income, following the death of the annuitant)
- Guaranteed payment periods; 5 years is typical but 10 year guarantees are possible
- Escalation of benefits; income can be protected from inflation - RPI linked escalation, alternatively a fixed % annual increase in income can be secured at outset e.g. 5%
- Annuity income can be linked to investment performance for example by a 'With Profit Annuity' or 'Unit Linked Annuity'
Whilst traditional annuities provide a guaranteed income for life, there are other types now available, namely With Profits & Unitised Annuities. They differ from traditional annuities as the guaranteed element is either reduced or taken away altogether in exchange for the possibility of increased income in the long term.
In respect to a With Profits annuity, a low guaranteed income level is initially secured and an annual bonus is payable from the With Profits Fund. The level of income therefore fluctuates from year to year and is dependent upon the success or otherwise of the With Profits fund.
With a Unitised Annuity, no guarantees are provided. The income received is dependent upon the underlying performance of the linked funds, which will fluctuate over time. With favourable market conditions, a unit linked annuity may, in the long term, produce income that exceeds that of a traditional level or escalating annuity. The reverse is also true - adverse conditions may seriously affect the value of a pension income.
Investment Solutions uses state-of-the-art research tools to find the best annuity rate available on the open market, specifically based on your circumstances.
3) Unsecured Pensions
Unsecured Pensions come in two forms: Phased Retirement, and Pension Fund Withdrawal.
If you intend to ease yourself into retirement gradually, then you might want to consider phasing your retirement. On a regular basis you can use part of your pension pot to provide a taxable income, or take a tax-free cash lump sum and reduced income. Your income can be provided either by buying an annuity or by income drawdown.
Phased retirement (also known as 'staggered vesting') allows the purchase of a pension to be phased, thereby allowing flexibility when considering retirement. Phased Retirement plans achieve this flexibility by periodically encashing segments of the plan to produce pension income. These plans are usually split into many individual segments, perhaps a 1,000 or more, to assist the process.
Each year the level of required pension income is determined; this subsequently determines the number of segments which must be encashed to meet the income need. The annual pension income is composed of a combination of tax free cash and annuity from the individual segments. The remainder of the fund remains invested and may benefit from any market growth in its underlying investments.
Phased retirement plans tend to carry higher management charges and, due to their natur,e are usually only considered suitable for clients holding pension assets in excess of £100,000. One other drawback of these types of plan is that the Pension Commencement Lump Sum (Tax-Free Cash) is not available on vesting the pension benefits into the Phased Plan.
The tax-free part of the encashed segments forms part of the annual pension income. Any remaining tax-free cash is not available until the final vesting of the remaining segments.
The option of what type of benefit to include upon death is made each time an annuity is purchased. The remaining fund i.e. the part not vested, can be paid on death as a tax-free lump sum to a nominated beneficiary.
Phased Retirement plans are relatively complex and are not suitable for everyone but they can for some individuals offer a flexible approach to retirement. Careful consideration must be given to an individual’s personal circumstances, including the value of their existing pensions. We strongly recommend advice from us be sought if you are considering this option.
Pension Fund Withdrawal
Pension fund withdrawal (also known as Income drawdown) is an important retirement option worth considering, particularly for individuals who have pension capital of at least £100,000.
Pension Fund Withdrawal plans were introduced following changes to Pension law in 1995. The changes removed the previous requirement to purchase an annuity at retirement.
Pension Fund Withdrawal allows an income to be taken directly from the pension fund itself. Pension Fund Withdrawal enhances the flexibility in that annuity purchase can be deferred until a time when it may be more suitable. Most of the major insurance companies now offer 'Income drawdown' plans.
These plans still allow up to 25% of the retirement fund to be taken as Tax Free Cash. Under Pension Fund Withdrawal there are now two options, Capped Drawdown or Flexi-Access Drawdown.
3) Unsecured Pensions (cont)
New Capped Drawdown contracts are no longer available (from 6th April 2015) but if you already have some funds in a capped drawdown plan, you may be able to add additional pension funds to the plan.
Existing Capped Drawdown plans can continue and can remain subject to the current rules on income limits and income reviews. As long as no more than the maximum income level is withdrawn each year, the plan can remain as capped drawdown. Should you withdraw income above the maximum limit your plan will become a Flexi-Access Drawdown plan (see below).
You can ask your Capped Drawdown Provider to alter your plan to a Flexi-Access Drawdown if required.
With Capped Drawdown you can elect to take a tax free lump sum and, rather than buy an annuity, leave the fund invested to continue growing tax free. An annual income can be taken from the fund if required. However a maximum level is set by the Government Actuary's Department (GAD) based on the size of the fund, age, sex and current gilt yields. These GAD tables are broadly equivalent to a single life annuity that you could have purchased. The maximum income can be no more 150% of the GAD rate. This GAD rate will be reviewed every 3 years, up to the anniversary of entering drawdown after your 75th birthday and annually thereafter.
There is no minimum income limit so an annuity does not need to be purchased so funds can remain invested until death. Upon death the residual fund can be taken as a lump sum with a 55% tax charge or the fund can be used to buy an annuity for the nominated beneficiary or they can continue to undertake drawdown until their death.
The main advantage of keeping withdrawals within the maximum limit is that the £10,000 money purchase annual allowance described below under Flexi-Access Drawdown will not apply. You can keep the full annual allowance (£40,000 in 2015/16).
Flexi-Access Drawdown is the new term for drawdown pension which allows you to place your pension funds in a drawdown plan and from age 55 withdraw as much or as little as you want over any period. Up to 25% of the fund can be taken as a tax free lump sum when the fund is placed in drawdown and any income taken will be taxed as pension income.
You will be able to make further pension contributions, however, if you take any income or withdraw a lump sum in addition to the tax free lump sum, you will have a reduced annual allowance of £10,000 for future contributions.
If you die with funds remaining in a drawdown plan your beneficiaries will have the option of continuing to take drawdown pension, buying an annuity or taking the remaining fund as a lump sum. If you die aged under 75, drawdown income, annuity income and lump sum payments will be tax free and if you die on or after age 75 the income payments are taxed on the recipients at their marginal rate(s) and the the lump sum is taxed at 45% in 2015/16 (expected to reduce to the recipient's marginal income tax rate(s) from the year after.
UNCRYSTALLISED FUNDS PENSION LUMP SUM (UFPLS)
You can withdraw a single or series of lump sums from your pension without the need to move the funds into a drawdown plan first. 25% of the fund (or 25% of each payment of UFPLS if less than the total fund is withdrawn) may be taken tax free with the balance taxed at your marginal rate(s) of income tax. Some pensions may not offer the flexibility to withdraw in a series of lump sums and it will be necessary to transfer to a more flexible arrangement unless you wish to withdraw the entire fund.
In order to take advantage of UFPLS a number of conditions need to be met.
A pension is a long term investment. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation. We strongly recommend advice from us be sought if you are considering this option.
What Considerations Should I Be Making?
The decisions you need to make at retirement are very important. There is a broad range of financial solutions available to you and getting truly independent financial advice is the best way to look at your options. Here are some things your adviser would recommend you think about:
- Your current financial circumstances
- The value of your pension funds and other sources of income
- Your retirement plans, income needs and capital needs
- Your general state of health and attitude towards risk
- Whether you have loved ones you would want to provide for when you die